UPDATE: HMRC has now published detailed VAT guidance explaining how Making Tax Digital will work in practice. Contrary to earlier Government statements (see below) from 1 April 2019 all VAT registered businesses (including charities) with a taxable turnover above the VAT threshold (£85,000) are required to keep their VAT business records digitally and send their VAT returns using Making Tax Digital (MTD) compatible software.

HMRC has published a Summary of Responses to its consultation on Bringing business tax into the digital age as part of the Making Tax Digital reforms.

CTG’s response to the MTD consultations, and its recent pre-Budget submission called for charities to be exempt from reporting and record-keeping requirements, while providing support for charities better able to comply to voluntarily opt-in.

Crucially, the Government has confirmed that it agrees and will therefore introduce legislation to exempt charities from the Making Tax Digital requirements.This is a welcome and pragmatic decision that will protect smaller charities and those with limited digital capability. However, it is important to note that charities are simply exempt from these new reporting requirements and we are seeking clarification from officials on the process for charities managing their existing ongoing tax reporting requirements, including the submission of nil-returns. Other online reporting mechanisms, for example for the Apprenticeship Levy (where relevant), PAYE and Charities Online, will continue to be in a digital form, and we await further guidance on the interplay between this and Making Tax Digital.

However, the Government has decided that charity trading subsidiaries should be within the scope of the Making Tax Digital obligations. CTG had called for trading subsidiaries to be included within the exemption as a charity will often use a subsidiary to make its activities tax effective or to accommodate any trading activities. This is often a requirement dictated by administrative, legal and financial practicalities. The charity is responsible for the administration of the subsidiary and processes and staff resources will often be shared across the organisation. Therefore, if a charity subsidiary was required to comply with these rules, it would mean that the charity would have to operate two systems (which adds complexity) or consider maintaining digital records for the whole charity group, undermining the proposed exemption. CTG also questions how this will work with a charity registered with its subsidiary in a VAT group, with potential for extra complexity. CTG will be looking to raise these concerns again with officials.

If the decision is taken to require charity trading subsidiaries to maintain digital records and update HMRC at least quarterly, we believe it would be sensible to introduce some form of transitional period and consider a size threshold to protect smaller organisations.

CTG is also hopeful that the Government will take forward recommendations to consider options to integrate Gift Aid operations for both charities and donors (including higher rate relief through Personal Tax Accounts) as systems develop as part of the Making Tax Digital agenda.

Overview of key points

HMRC explained its decisions on charities and their subsidiaries as follows:

“The consultation document made it clear that HMRC considered it appropriate for charities to be exempted from the Making Tax Digital for Business [MTDfB] requirements, whilst commenting that there were significant potential benefits for charities in maintaining digital records and in using software to update their digital tax account where they do need to make a return for corporation tax or Income Tax Self Assessment. Having considered all the responses our view remains unchanged, and the government will therefore introduce legislation to exempt charities from the Making Tax Digital requirements.”

The charity carve-out will not, however, apply to their trading subsidiaries:

“Charities often establish trading subsidiaries to keep the trading activities separate from the charitable activities, and because profits are starting to exceed the small, trading profits exemption limit available to charities. This puts their business activities on a closer footing with non-charitable businesses.

While the proposal to exempt those trading companies who distribute all profits to charity (and therefore had no corporation tax liability) had some merit, they could still have substantive VAT obligations. A significant reason for exempting charities is that many of them do not currently have to submit a tax return, and have a number of reliefs available to them for VAT purposes. Additionally, we considered there would be non-charitable businesses who ordinarily would submit a return but sometimes have no liability to direct tax, but will still be within the scope of Making Tax Digital. This weakens the argument for exemption for trading subsidiaries owned by charities for having no taxable profit and therefore no direct tax liability.

Accordingly, the government’s view is that trading companies owned by charities should be within the scope of the Making Tax Digital obligations.”

Other proposals

Other proposals include, that:

businesses will be able to continue to use spreadsheets to record receipts and expenditure, which they can then link to software to automatically generate and send their updates to HMRC

free software will be available to the majority of the smallest businesses

businesses that cannot go digital will not be required to do so

all self-employed businesses and landlords with a turnover under £10,000 a year will not have to keep their records digitally or make quarterly updates, but can do so if they wish

the option to account for income and expenditure on a simple ‘cash in, cash out’ basis will be extended, helping an extra 2.5 million self-employed businesses and unincorporated landlords

customers will have at least 12 months to become familiar with the changes before any late submission penalties will be applied; following feedback from respondents, HMRC will also consult again in the spring on a new penalty model

HMRC will pilot these digital systems with hundreds of thousands of businesses before rolling them out to ensure the software is user friendly, and to give businesses and landlords time to prepare and adapt

the requirement to keep digital records will not mean that organisations will have to make and store invoices and receipts digitally;

activity at the end of the year will have be concluded and sent either by ten months after the last day of the period of account or 31 January, whichever of these is soonest.

HMRC has also confirmed that the Government will need to consider further issues, such as the initial exemption threshold and deferring the changes for some small businesses alongside their cost, with final decisions to be made before legislation is introduced later this year.